Question

Put yourself in the shoes of a company president: The extremely successful launch of a new product has resulted in an additional $5 million in unexpected operating cash flows. You can think of several ways to use the extra $5 million. One alternative is to pay out a special dividend to the shareholders. As president, you are accountable to the board of directors, which is elected by the shareholders. Rather than pay a dividend, you could repurchase shares of the company’s own stock. The stock seems current to be underpriced, and by purchasing treasury shares you are distributing surplus cash to shareholders without giving them taxable dividend income. You could also pay a special year-end bonus to your employees. With 500 employees, that would average $10,000 per employee, quite a nice holiday bonus. After all, it was the employees’ hard work and dedication that earned the money in the first place. Or you could use the money to reinvest in the company. By reinvesting the money, it might be easier to continue the upward earnings trend in the future. Finally, you could approach the board of directors for a compensation adjustment of your own. It’s been a great year, and you are the president of the company. Shouldn’t you at least share in the success?

Required: Determine how you would allocate the additional $5 million. Are there other areas in which to spend the money not mentioned in the above case? Is it ethical for the president to be directly compensated based on the company’s performance each year?

Answer 1

Options available for the President have been evaluated as follows:-

Option	Reasons in Favour	Reasons against
Special Dividend	1. Investors get rewarded for faith reposed in company 2. Markets may react favourably: increase in share price and hence wealth of investors	1. Cash not being used to put to use for furtherance of Business 2. Future needs not evaluated 3. Dividend would be taxed in the hands of shareholders
Repurchase of Shares	1. Rewarding the investors 2. Increase in shareholder wealth 3. Improvement in share price	1. Future needs not evaluated
Special Year end Bonus	1. Improvement in employee morale 2. In near and short term increase attractiveness as an employer	1. May create unrealistic expectation in employees in subsequent year 2. If bonus is not matched in subsequent years, may create employee dissatisfaction
Re-investing in Business	1. Increasing busines profitability 2. Increasing shareholder value	1. Would require time to evaluate options/ avenues for business improvments 2. In haste to invest, may end up taking incorrect decision or one which is detrimental to business
Additional Compensation for president	1. Rewarding leadership	1. Does not allow team participation in reward 2. May not be appreciated by markets, Board and employees

Each of the stated options can be argued for or against. However, the President should evaluate spending on the following parameters:-

1. Return on Investment

2. Future cash flows

3. Impact on Business

An evaluation should be done of the options and the most efficient combination or option should be deployed. Unless a thorough evaluation of options or combination of options is done, the decision to deploy the surplus cash flow should not be taken.

Leadership is generally rewarded ( or penalised, for that matter) on value creation. In this context, a successful product launch should be rewarded. However, it is for the Board to come up with the recommendation, rather than the President to seek it.

In summation:-

1. To do an evaluation to arrive at the most efficient option or combination of options

2. President may be rewarded based on the Boards assessment of value created.